Unformatted text preview: idend growth rate to 6%
and lower the required return to 14%.
c. Eliminate an unprofitable product line, which will increase the dividend
growth rate to 7% and raise the required return to 17%.
d. Merge with another firm, which will reduce the growth rate to 4% and raise
the required return to 16%.
e. Acquire a subsidiary operation from another manufacturer. The acquisition
should increase the dividend growth rate to 8% and increase the required
return to 17%. LG6 7–21 Integrative—Valuation and CAPM formulas Given the following information
for the stock of Foster Company, calculate its beta.
Current price per share of common
Expected dividend per share next year
Constant annual dividend growth rate
Risk-free rate of return
Return on market portfolio LG4 LG6 7–22 $50.00
10% Integrative—Risk and valuation Giant Enterprises has a beta of 1.20, the riskfree rate of return is currently 10%, and the market return is 14%. The company, which plans to pay a dividend of $2.60 per share in the coming year,
anticipates that its future dividends will increase at an annual rate consistent
with that experienced over the 1997–2003 period, when the following dividends
Year Dividend per share 2003 $2.45 2002 2.28 2001 2.10 2000 1.95 1999 1.82 1998 1.80 1997 1.73 a. Use the capital asset pricing model (CAPM) to determine the required return
on Giant’s stock.
b. Using the constant-growth model and your finding in part a, estimate the
value of Giant’s stock.
c. Explain what effect, if any, a decrease in beta would have on the value of
Giant’s stock. 348 PART 2 LG4 LG6 Important Financial Concepts 7–23 Integrative—Valuation and CAPM Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash.
Hamlin wishes to use the capital asset pricing model (CAPM) to determine the
applicable discount rate to use as an input to the constant-growth valuation
model. Craft’s stock is not publicly traded. After studying the betas of firms similar to Craft that are publicly traded, Hamlin believes that an appropriate beta
for Craft’s stock would be 1.25. The risk-free rate is currently 9%, and the market return is 13%. Craft’s dividend per share for each of the past 6 years is
shown in the following table.
Year Dividend per share 2003 $3.44 2002 3.28 2001 3.15 2000 2.90 1999 2.75 1998 2.45 a. Given that Craft is expected to pay a dividend of $3.68 next year, determine
the maximum cash price that Hamlin should pay for each share of Craft.
b. Discuss the use of the CAPM for estimating the value of common stock, and
describe the effect on the resulting value of Craft of:
(1) A decrease in its dividend growth rate of 2% from that exhibited over the
(2) A decrease in its beta to 1. CHAPTER 7 CASE Assessing the Impact of Suarez Manufacturing’s
Proposed Risky Investment on Its Stock Value E arly in 2004, Inez Marcus, the chief financial officer for Suarez Manufacturing, was given the task of assessing the impact of a pr...
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